Advanced Techniques in Day Trading: A Practical Guide to High Probability Day Trading Strategies and Methods

Nasdaq Level 2 and Bid-Ask

As part of your data feed package, you will have access to Nasdaq Level 2. Level 2 can provide important insight into a stock's price action, including what type of traders are buying or selling a stock and where the stock is likely to head in the near term. Level 2 is known to be a “leading indicator”, which means it shows activity before a trade happens. Moving averages, charts and most of the other indicators are known as “lagging indicators”, meaning they provide information after the trades take place.

Level 2 is essentially the order book for Nasdaq stocks. When orders are placed, they are placed through many different market makers and other market participants. Level 2 will show you a ranked list of the best bid and ask prices from each of these participants, giving you detailed insight into the price action. Knowing exactly who has an interest in a stock can be extremely useful, especially if you are day trading. Figure 2.17 below is an example of what a Level 2 quote looks like:

Figure 2.17 - Example of the Nasdaq Level 2 for MOMO Inc. (ticker: MOMO) in the middle of the trading day. Note that the number of shares (the “SIZE”) is in hundreds (×100).

Whenever the market is open, there are always two prices for any trading stock - a bid and an ask. A bid is what people are offering to pay for that stock at that moment; an ask is what sellers are demanding in order to sell it. A bid is always lower, an ask is always higher, and the difference is called the bid-ask spread. Bid-ask spreads vary for each stock and even for the same stock at different times of the day.

Figure 2.17 above shows you (first row, right-hand side of the chart) that someone is offering 300 shares (3 (the “SIZE”, the number of lots of shares) x 100 shares/lot) of MOMO for $37.27 on the ask side through EDGX (a market maker). Another trader is selling 100 shares at $37.27 through BATS, a different market maker. On the bid side, there are various market players who are willing to buy shares of MOMO at a price of $37.23. Traders who want to buy MOMO at various prices are sending their bids through market makers to the bid side of the Level 2 (BATS, NASD and NSDQ are some of the market makers active on this stock).

The most important information you must take away from Level 2 is the bid-ask spreads. Spreads are higher in lower volume traded stocks, as the market makers who dominate such stocks demand higher fees from those who want to join their party.

The bid-ask spreads are likely to be small, perhaps only one cent on a quiet day in an actively traded stock. They grow wider as prices accelerate on the way up or down and may become huge — I have seen up to $2 — after a severe drop or a very sharp rally.